The effects of budget deficits and public debt on real interest rates in Kenya

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Abstract

The subject of Public Expenditure, Public Debt and government financing has
dominated the social airwaves in Kenya in the recent past. The enshrouding debate
that the government is living beyond its means is now almost becoming synonymous
with every Kenyan in the street and the households experience in the consumption
system. This has now brought a sharp focus to the policy analysts, policy makers and
academicians. It is upon this ground that the present study sought to investigate the
effects of budget deficit and public debt on real interest rates in Kenya for 37 years
(1978-2014). The study adopted yearly data series as the data availability dictated.
Focusing on answering two research questions advanced in the maiden chapter of the
study, the variables were subjected to unit root test using Phillips-Peron and
Augmented Dickey Fuller. The test found out that budget deficit variable was not
stationary at level, while all the remaining variables had constant moments at level.
This therefore ensured that the only available model of analysis is the ARDL
(Autoregressive Distributive Lag). The ARDL model proved signifiant and jointly
resulted into a result of all the variables causing real interest rate in Kenya at 76%
contribution range. On the other hand, it is interesting that only CPI variable had a
significant contribution to Real Interest rate in Kenya in the Long run. This is an
interesting bit of this study as the main variables such as Public Debt and Budget
Deficit did not reveal to be significant. The reuslt is in contravention with apriori. The
results also indicate that the two of the investigated variables have causality running
from real interest rate at 5% significance level. Public Debt and GDP growth proved
to be caused by Real Interest Rate in the long run.